U.S. Agency Wants Brokers Held to Higher Standards

In September 2008, as the financial crisis emerged, a retirement account of Al and Karin Betz slumped in value to $130,000 from about $160,000.

“I got a cold call saying, ‘Would you have some money to invest?’” Al Betz, 66, recalled.”I said, ‘If you can do better, I’ll give it a try.’”

The Crystal Lake couple said they were told that their principal would be protected and that they’d get high returns thanks to a “unique system.”

After the account dwindled to about $3,000, the Betzes filed a claim against the brokerage, accusing it of putting their money in unsuitable investments, such as penny stocks, which can be risky, and making excessive trades.

“When they were selling or buying, they got a certain fee,” Karin Betz, 64, said. “They got richer when we got poorer.”

A lawyer representing National Securities said the firm did nothing wrong.

The Betzes’ situation is illustrative of confusion in the marketplace over the responsibility of brokers handling retirement accounts — something the U.S. Department of Labor is trying to remedy.

The agency, at the behest of President Barack Obama, wants a more demanding “fiduciary” standard required of brokers who make investment recommendations, meaning they would have to act in the client’s best interest. Currently, brokers need only consider whether investments are “suitable,” taking into consideration such factors as customers’ ages, income and appetite for risk.

At an AARP meeting in February, Obama said some advisers “receive backdoor payments or hidden fees for steering people into retirement investments that have high fees and low returns.” Such practices, he said, strip about $17 billion a year from peoples’ retirement savings.

“The challenge we’ve got right now: There are no uniform rules of the road that require retirement advisers to act in the best interests of their clients,” Obama said.

Obama mentioned Merlin and Elaine Toffel, a retired Lindenhurst couple that “got bad advice to invest in expensive annuities that made it hard for them to access their money.”

“They were taken advantage of by an adviser of an institution where they had been longtime clients, and it was an institution they trusted,” Obama said. “They’re not alone.”

On average, conflicts of interest in retirement advice results in annual losses of 1 percentage point for affected persons, Obama said. “I know 1 percent may not sound like a lot, but the whole concept of compounding interest — it adds up,” Obama said.

A 30-page report from the White House Council of Economic Advisers titled “Effects of Conflicted Advice on Retirement Savings,” also released in February, said people receiving conflicted advice reduce what would be a 6 percent return to a 5 percent return.

“Such savers hold about $1.7 trillion of IRA assets,” the council said. “Thus, we estimate the aggregate annual cost of conflicted advice is about $17 billion each year.” Even a more conservative estimate — say, a half of a percentage point — would reflect losses of more than $8 billion a year, the council said.

Just last month, Securities and Exchange Commission Chair Mary Jo White told a U.S. House financial services committee that broker-dealers should be subject to the same fiduciary standard as registered investment advisers when dealing with retail investors.

Breach of fiduciary duty is the single most common cause of action alleged in arbitration cases, according to statistics from the Financial Industry Regulatory Authority, an independent, nonprofit body authorized by Congress to protect U.S. investors by ensuring the securities industry operates fairly.

“To the extent that fiduciary duties are imposed on all brokers, there’s a very good chance that might put me out of business,” said Andrew Stoltmann, a Chicago securities lawyer representing the Betzes.

In 2014, for example, 3,822 arbitration cases were filed with the Financial Industry Regulatory Authority. Of those, 2,106 alleged breach of fiduciary duty.

“Unfortunately, it is more difficult to determine how often breach of fiduciary duty claims are successful, since cases usually have multiple causes of action and arbitrators rarely state the basis on which they decide the case,” says Richard Ryder, president of Securities Arbitration Commentator, a New Jersey-based research service that tracks data from arbitration awards.

Indeed, the claim filed by Al and Karin Betz has numerous allegations, including breach of fiduciary duty, excessive trading, negligence, failure to supervise and breach of contract.

“It is clear that brokers are fiduciaries, owing their customers a duty of utmost good faith,” their claim says.

Claims of breach of fiduciary duty in securities cases have hit some household names.

In December 2013, the brokerage unit of Wells Fargo was ordered by a FINRA arbitration panel to buy back $94 million in auction-rate securities from a group of investors. A request for $20 million in damages was denied, however, FINRA records show.

Allegations in both cases included breach of fiduciary duty, negligence and breach of contract. Many brokers’ questionable activities would cease if they were held to a fiduciary standard, Stoltmann, their lawyer, said. Of the 1,000 arbitration cases he has filed for investors, 98 percent have been against brokers, he said, with the rest being against registered investment advisers, who are fiduciaries.

“You want to talk about cleaning up the business, eliminating excessive trading and unsuitable investments — impose a fiduciary duty on those guys,” Stoltmann said.

The Betzes, who were born and raised in Germany, came to the United States in 1980 for Al Betz’s job. An engineer by training, he worked for a global environmental technologies company for 32 years, first in Detroit and then in Crystal Lake.

Al Betz retired from the company more than 10 years ago. At that point he and his wife started Northwestern Sunrooms, which designs and builds sunrooms, and Betz Design, which makes clothing and window treatments. They became U.S. citizens in 2010.

The businesses are doing “OK,” Al Betz said.

Al Betz said the couple trusted the brokerage, including their advice to buy more shares when they were in a steep decline. “I was not about to try to second guess them,” he said.

As their accounts dwindled to about $60,000, the couple said they showed up at the brokerage’s downtown office in 2009 and reiterated that they needed the money for their retirement, “which we thought to be just a couple of years away,” Al Betz said.

When the value dwindled to $3,000 by the end of 2013, he said he ordered the brokers to never again sell at a loss. Last year, the couple filed a claim against the brokerage with the Financial Industry Regulatory Authority.

“The ‘superior investment method,’ which in reality was nothing more than excessively trading the claimants’ accounts, wiped out virtually their entire portfolio at a time when the equity markets made significant gains,” their claim said. The couple’s investments also were heavily weighted into “small capitalization” stocks and the portfolio wasn’t diversified, their claim said.

“Diversification is one of the most important strategies to decrease risk in a portfolio, which was completely necessary for customers like Mr. and Mrs. Betz, who were nearing retirement and couldn’t afford to lose these funds,” their claim with FINRA says. “The importance of diversification across different asset classes and within asset classes to decrease risk is a well-established” investment principle.

Al Betz said he trusted the brokers and didn’t consider checking them out. “I didn’t know how to go about doing that,” he said.

Relatively few investors check out their brokers, Stoltmann said. “You can do it online, but most people aren’t aware of that,” he said. “People think brokers, like doctors, CPAs and lawyers, have a duty to act in their clients’ best interest, but there’s a real disconnect between what people get and what they think they’re getting.” Most people don’t second-guess their doctors, accountants, lawyers or brokers, he said.

The home page of FINRA.org includes a feature called BrokerCheck in which the public can type in names of firms or individuals to see if they’ve been the subject of complaints.

The Committee for the Fiduciary Standard, which was formed in June 2009 by a group of investment professionals and fiduciary watchdogs, on its website has an oath that investors can ask advisers and brokers to sign, vowing that they’re acting as a fiduciary. Investors should ask their brokers to sign it, Stoltmann said.

According to the report by the White House Council of Economic Advisers, certain professionals “can switch back and forth” between being a broker and a registered investment adviser, “a practice known as dual hatting.”

“As a result, consumers may not know” whether they’re receiving advice under “fiduciary” or “suitable” standards “at any moment,” it said in its report.

Even if someone signs the pledge or is in fact a fiduciary doesn’t mean problems can’t occur.

Last year, Seattle investment adviser Mark Spangler, a former chairman of the National Association of Personal Financial Advisors, was sentenced to 16 years in prison for wire fraud, money laundering and investment adviser fraud.

“The evidence at trial demonstrated that Spangler repeatedly violated his fiduciary duty as an investment adviser by hiding where his clients’ money was invested and by providing them with false account statements which, among other things, drastically inflated the value of their investments,” a Justice Department press release said.

The three brokers who handled the money of Al and Karin Betz aren’t formally named as parties in the arbitration action against National Securities, but combined have been named in about 20 customer complaints, including allegations of excessive trading and recommending unsuitable investments, according to FINRA. One had personal financial problems on his record, FINRA records show.

“National Securities denies all allegations contained in the statement of claim and intends to vigorously defend this action,” said the firm’s Chicago lawyer, Gara Seagraves of Baugh Dalton.

The Betzes’ claim alleges that National Securities failed to “reasonably supervise” the advisers and that the high turnover rate of their investment holdings should have been a red flag. “A turnover rate of six and above in all three retirement accounts should have led National Securities to shut these accounts down and review its agents’ conduct,” their claim said.

The turnover rate in the Betz accounts, in their names individually and as a married couple, ranged from 6.3 to 9.2, the number reflecting how often their investment holdings were replaced in a year, their claim said.

Mutual funds that seek aggressive growth might have a turnover ratio of 1.2 a year, Stoltmann, their lawyer, said.

High turnover rates generate more fees and commissions for brokerages and, in turn, reduce returns for investors.

The Betzes, who have two sons and two grandchildren, said the money they lost equals about a quarter of their retirement savings. The rest of the couple’s retirement funds are in investment vehicles mirroring the Standard & Poor’s 500. The couple also receives Social Security.

Still, the losses have “pushed back our retirement,” Al Betz said in an interview.

The couple said they believe they’re entitled to damages of nearly $215,000, the amount they think their accounts would be worth had they not been mismanaged.

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